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United Continental Holdings Inc. Can't Afford Any More Earnings Wipeouts

United Continental Holdings Inc. has used up all of its excuses. Now it's time to show that it can get back to the top of the airline industry.

Earnings season has barely begun, but investors in United Continental Holdings Inc.(NYSE:UAL) have already written off Q1 as a disaster for the world's second-largest airline. Due to a combination of unusually bad weather, a calendar shift related to the timing of Easter, and heavy competition on some of its key routes, United is expected to post a bigger Q1 loss than it did last year.

United is going to post an ugly Q1 loss later this month. Source: The Motley Fool

Some analysts have expressed concern about United's performance, but most have been willing to place the blame for a weak Q1 on one-time factors. Either way, United can't afford any more costly mistakes. Right now, the airline industry environment is as good as it's going to get. If United can't keep up with the competition this year, it's not likely to have any more success later.

A dreadful Q1 performanceAfter providing fairly mediocre Q1 guidance back in January, United Continental has had to lower expectations twice. This week, United published an investor update on Q1 performance that projects a 1.5%-2.5% decline in unit revenue alongside a slight increase in unit costs. The net result will be a loss of around $500 million.

Meanwhile, both of its top rivals -- American Airlines (NASDAQ:AAL) and Delta Air Lines(NYSE:DAL) -- are expected to post solid Q1 earnings. Both of these carriers faced essentially the same weather issues as United. The Easter calendar shift affected all carriers equally, too.

Bad weather and the Easter calendar shift couldn't keep profit down at Delta Air Lines. Source: The Motley Fool

Somehow, Delta was able to overcome the adversity last quarter. Earlier this month, it projected that its Q1 operating margin will reach 6.5%-7.5%, up from just 3.5% last year. American Airlines is not far behind, with a projected operating margin of 5%-7%. For United Continental, the comparable figure will be approximately -3%.

United needs a quick recoveryLast month, I argued that United executives have fallen back on lame excuses to explain away weak performance time and again. A one-time issue can be a reasonable explanation for poor results in a single quarter, but a series of one-time issues is indicative of some kind of bigger problem.

After its terrible Q1 performance, the best way for United to prove that all of the "bigger problems" are resolved is to come back with a strong performance in Q2 and the rest of the year.

Given the favorable industry environment this year -- stable or falling jet fuel costs, steady GDP growth, and a virtual oligopoly created by recent mergers -- every major airline should be able to grow earnings this year. United's task is to improve its earnings at least as fast as Delta and American over the last nine months of 2014. (If it keeps losing ground, it will be in trouble when the next industry downturn hits.)

The keys to success (or failure)United has some tailwinds coming this year that could help it catch up to its legacy carrier rivals. For example, while United faced higher-than-average capacity growth by competitors in its markets last year, this trend is slowing according to one Wall Street analyst.

Additionally, a suboptimal revenue management algorithm caused United to sell too many seats at discounted prices last year. The company fixed this issue last fall, which should allow it to generate higher yields on peak days in 2014.

On the flip side, United also faces some headwinds. First, as part of its merger with American Airlines, US Airways just moved from United's Star Alliance to the Oneworld alliance. This could remove a significant source of traffic for United's lucrative Asian routes.

The US Airways-American merger could divert U.S-Asia traffic away from United. Source: American Airlines

Second, Delta and Virgin Atlantic recently implemented a new joint schedule for flights between the U.S. and the U.K. This puts United in a distant third place for flights on the New York-London route: the most important international route for business travel out of the U.S.

Third, United is currently one of the strongest players on transcontinental routes from New York's JFK Airport to Los Angeles and San Francisco. These are some of the most lucrative routes in the airline industry, but they are getting a big increase in competition later this year and in 2015.

Foolish bottom lineUnited's performance for the rest of 2014 will depend on whether the positive factors noted here outweigh the negatives. In Q2 specifically, all of the airlines will benefit from the Easter shift. As a result, Delta, American, and United should all see big year-over-year profit gains, excluding changes in tax rates.

Investors should be looking for United to guide toward a unit revenue increase of at least 4%-5% when it reports earnings later this month. Anything better would be a great sign of progress in the company's turnaround. Anything worse would suggest that United is not nearly out of the woods.

Author

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry! Follow @AdamLLW